A bank has $200 million in checking deposits with interest and non-interest costs of 4%,$400 million in savings and time deposits with interest and non-interest costs of 8%,and $200 million in equity capital with a cost of 24%.The bank has estimated that reserve requirements,deposit insurance fees,and uncollected balances reduce the amount of money available on checking deposits by 10% and on savings and time deposits by 5%.What is the bank's before-tax cost of funds?
A)11.00%
B)11.26%
C)11.50%
D)12.00%
E)None of the options is correct

Question

Quizplus · Accepted Answer

To calculate the before-tax cost of funds, we need to calculate the weighted average cost of funds (WACF).

First, we calculate the interest and non-interest costs for each type of deposit:

Checking deposits: $200 million x 4% = $8 million
Savings and time deposits: $400 million x 8% = $32 million

Then, we adjust for the reduction in available funds due to reserve requirements, deposit insurance fees, and uncollected balances:

Checking deposits: $8 million x (1 - 0.10) = $7.2 million
Savings and time deposits: $32 million x (1 - 0.05) = $30.4 million

Next, we calculate the total cost of funds (interest and non-interest costs) and the total amount of funds available:

Total cost of funds: $7.2 million + $30.4 million + ($200 million x 24%) = $67.6 million
Total funds available: $200 million + $400 million = $600 million

Finally, we calculate the WACF:

WACF = Total cost of funds / Total funds available
WACF = $67.6 million / $600 million
WACF = 0.1126 or 11.26%

Therefore, the before-tax cost of funds is 11.26%, which corresponds to answer choice B.

A Bank Has $200 Million in Checking Deposits with Interest